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Richard Duncan, author of The Dollar Crisis has some interesting views on the economy.  They are a bit off the beaten path, but very much worth pondering.

Summing up his views…

THE FACTORS THAT LEAD TO A GROWING ECONOMY

Economic growth is achieved by two events.  New workers coming into the work place and credit growth.  Both are now failing.

We have shrinking demographics and less income growth.

Credit growth drove the economy since 1960.  In 1964 it was one trillion.  Now it’s $58 trillion, a 58-times expansion of credit.

In 2008 credit started to contract.  The Fed reacted by instituting QE and since then the Fed has increased its balance sheet by $3 trillion.

QE drove the economy, taking the place of the contraction in credit growth.

The household sector net worth is up 40 percent  since the onset of QE.   Stocks are up.  Property values are up.  The increase in wealth is holding things together.  The Fed needs the wealth effect from rising stocks and housing.  The stock market is driven by QE liquidity, but if the Fed tapers the stock market could crash.  The Fed will have to taper gently.  They will have to find a balance, supporting the “wealth effect” without simultaneously creating a stock market “bubble.”  (Honestly, I think that they already have!)

The economy used to be driven by labor and income growth; now its added leverage – QE, which pours into the stock and housing market and creates the “wealth effect,” which spills back into the economy.

We live in the later stages of an aging population (aging baby boomers), which has pushed the Labor Participation Rate back to levels last seen in the 1970s.

Globalization is holding down wages.

Credit growth must be OVER 2 PERCENT AFTER INFLATION to support the economy.  Credit grew 9-fold from 1952 to 2007 before the recession set in.  Is the recession over?  Recessions don’t end until credit rises above 2 percent after inflation and that has yet to happen.

To catch up, credit needs to grow 4 percent!  It needs to grow to $58 trillion, which requires an additional $2.3 trillion of NEW CREDIT GROWTH.   Without this much growth in credit we won’t be able to stimulate the economy.  IT WON’T HAPPEN.

THE EFFECT OF BUDGET DEFICITS ON THE ECONOMY

Most people believe that a SHRINKING budget deficit is a good thing.  From its peak, our budget deficit will shrink by $400 billion in 2014.  But that means $400 billion LESS re-circulating back into our economy.

China recycles their budget surplus (which comes from our dollars traded for their Walmart everythings) back into our economy.  What else can you do with dollars?  You spend them in the US (sooner or later).  If China spends the surplus to buy euro or with other countries, the dollars eventually will come back into our Treasuries, either directly or indirectly, second hand.

Never forget that liquidity drives asset growth!  Fiat money is created by central banks printing money to finance government borrowing.  Government borrowing sucks liquidity OUT with increased BUDGET DEFICITS.

Non-U.S. central banks with trade surplus dollars CREATE LIQUIDITY.  China has $3.7 trillion in foreign currency reserves.  They create yuan to buy U.S. dollars from Chinese industry, which arrive by their trade surplus.  They need to re-invest these dollars to get interest.

The U.S. Current Account Deficit peaked in 2006 at $800 billion.  They were accumulated by foreign central banks and RECYCLED BACK to the U.S.  This year there will only be $400 billion recycled back, a drop of $400 billion!  (See article in Jim Sinclair’s portion of the Featured Articles section on trade deficit with China)

In order to compensate for the loss the Fed created between one trillion and $1.4 trillion of fiat liquidity (QE). The projected deficit for 2014 is “only” $700 billion so that leaves an extra $700 billion of liquidity to flow into stocks and real estate – all courtesy of the Fed and their massive excess liquidity.

The problem is the excess liquidity inflates assets (stocks, housing).  When there is negative liquidity, assets fall.  The Fed’s QE plus our trade deficit (which is recycled back to the U.S.) equals liquidity.

Our budget deficit with China is around $330 billion.  What will they do with it?  Buy dollar assets, of course.  There is nothing else they can do (if they want a return on the surplus).  And we support their economy by buying their products.  THEY MUST ACCUMULATE DOLLARS (TO SUPPORT THEIR ECONOMY) AND THEY MUST BUY U.S. TREASURYS TO GET INTEREST.

All of this reminds me of the uneasy truce that the rival biker gangs (Sons of Anarchy and Mayans) maintain in the great series, Sons of Anarchy.  Highly recommended!

To wrap this up, remember what Bill Holter is often pointing out – China will continue to accept dollars as long as they can recycle them for physical gold.  That is an over-simplification, but it rings strongly of the truth.  They need us, we need them, and THEY NEED OUR GOLD.  And so we oblige.  But that will soon come to an end and then we will let the politicians work it out, while we revel in the massive new wealth our gold holdings will reflect.